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4 November marks the second anniversary of the European Central Bank (ECB) as banking supervisor. The fog of the financial crisis has not yet fully lifted, and the financial stability of the sector continues to be challenged by individual events nearly impossible to anticipate: Brexit, the situation in Turkey, some European financial sectors under scrutiny, and political instabilities to name a few. It’s easy to say that the first two years of ECB supervision have been interesting.

This second year of supervision will end with the communication to the significant banks regarding the capital decision, based on the SSM common Supervisory Review and Evaluation Process (SREP) methodology for the ongoing assessment of credit institutions’ risks, governance arrangements and capital and liquidity situation, which have been carefully tailored to the Eurozone banks’ situations.

2015 vs. 2016 – what’s the difference?

One of the main questions that the financial sector is eager to know is, “Is SREP 2016 going to be comparable with SREP 2015?” Arguably, the capital decisions are hardly comparable for several reasons:

The results of the EBA/ECB Stress Test 2016 exercise were available at the end of July 2016. They are going to be crucial inputs into the SREP 2016 (non-existent in 2015).

The differentiation between Pillar 2 Requirement (P2R) and Pillar 2 Guideline (P2G), present in the current year decision – for more details see below.

The ECB changes included in the SREP methodology, as it is a living document that frequently receives feedback and input.

The inclusion of findings from several Thematic Reviews, used as proxies in the SREP; including corporate governance, leverage finance, non performing exposures, and the continuity of the thematic review on cyber risk, RDA, and business model analysis, which did not come into play in SREP 2015.

What can we expect form SREP 2016?

According to SREP 2015 the average CET1 level was set at around 10 percent, which was approximately 20 percent above the levels required for such own funds in 2014 that already represented an increase of 40 percent with respect to the minimum requirements according to Pillar1 Regulation. However, discrimination between banks was low, and it generated a relevant controversy regarding the MDA calculation and the disclosure (banks from several countries decided to publish their capital decision while others decided to keep it as confidential).

The ECB already informed the industry of one of the main differences between SREP 2015 and SREP 2016 (the picture below is illustrative of the main differences). Following the EBA general guidance (communicated as of 1 July 2016), SREP decisions of 2016 will be composed of a Pillar 2 Requirement (P2R) and a Pillar 2 Guidance (P2G). Banks are expected to meet the P2G (set above the level of binding capital requirements and on top of the combined buffers); however, this P2G will not be used to determine the MDA trigger.

Anticipated timeline

At this point in time, it seems that the calendar for the SREP decision will not change. Submission of the draft capital and liquidity joint decisions and qualitative measures to the Supervisory Board took place at the end of August 2016; and its subsequent approval is due in the beginning of September. In mid-September the draft decisions are to be formally communicated to the banks; this will be followed by the ‘Right to be heard’ – a two-week period of consultation with the banks, either by hearing or written process. By the end of October the final joint decisions (capital and liquidity) and the final qualitative measures will be submitted to the Supervisory Board for approval, which will take place in mid-November. After the approval of the Governing Council, the final signed SREP decision letters will be sent to banks for the end of November.

Conclusion

Although SREP 2016 will solve some of 2015´s controversies, there are still, some open questions:

What will be the level of discrimination between banks?

How is the ECB going to deal with the publication?

Is the ECB taking into consideration the joint impact MREL-P2G-P2R?

How does the supervisor deal with RWA´s inflating regulatory and supervisory initiatives (i.e. Basel IV) in such a way that capital demand does not increase beyond supervisory expectations?

When this article was written, SREP decisions hand not been made yet. The ECB had thus far informal discussions with several SSM banks. From the initial feedback that we received from clients, one could say that average CET1 demand remains broadly stable when compared to 2015 decisions. Worth to highlight the reduction in MDA trigger between SREP 2016 and SREP 2015; since P2G is not MDA relevant in the current year’s SREP, there is on average a reduction of 150 – 190 bp in the MDA trigger.